16 August 2005

Economics & Prosperity I

Economics is often shrouded in fog, most of it because economists are using smoke and mirrors and some of it self-induced by people's misunderstanding of money, social exchanges and the concept of value.

From Part I, Ten Key Elements of Economics, extracts of True Importance:

5. Increases in Real Income are Dependent Upon Increases in Real Output

A HIGHER INCOME AND STANDARD OF LIVING are dependent upon higher productivity and output. There is a direct relationship between a nation's per capita (per person) income and its per capita output. In essence, output and income are opposite sides of the same coin. Output is the value of the goods and services produced, as measured by the prices paid by purchasers. Income is the revenue paid to the people (including the entrepreneur's residual revenue), who supply the resources that generate the output. This too, must equal the sale price of the goods.

...Once the linkage between output and income is recognized, the real source of economic progress is clarified. We improve our standard of living (income) by figuring out how to produce more output (things that people value). Economic progress is dependent, for example, on our ability to build a better house, computer, or video camera with the same or a lesser amount of labour and other resources. Without increases in real output - that is, output adjusted for inflation - there can be no increases in income and no improvement in our living standards.

...Politicians often erroneously talk as if the creation of jobs is the source of economic progress. While campaigning, a recent political leader argued that his economic program had three pillars: "Jobs, jobs, and jobs." But focusing on jobs is a potential source of confusion. More employment will not promote economic progress, unless the employment expands output. We do not need more jobs, per se. Rather we need more productive workers, more productivity-enhancing machinery, and more efficient economic organization so we can produce more output per capita.

Some observers argue that technology adversely affects workers. In fact, just the opposite is true. Once you recognize that expansion in output is the source of higher wages, the positive impact of improvements in technology is apparent: better technology makes it possible for workers to produce more and thus to earn more.

...Sometimes specific jobs will be eliminated. Clearly modern technology has largely eliminated the jobs of elevator operators, blacksmiths, household workers, ditch diggers, and buggy manufacturers. These changes, however, merely release human resources so they can be used to expand output in other areas. Other tasks can now be accomplished with the newly released resources and, as a result, we are able to achieve a higher standard of living than would otherwise be the case.

Recognition of the link between output and income also makes it easier to see why minimum wage legislation and labour unions fail to increase the overall wages of workers. A higher minimum wage will price some low-skill workers out of the market. Therefore, their employment will decline, reducing total output. While some individual workers may be helped, overall per capita income will be lower because per capita output will be lower.

Similarly, labour unions may be able to reduce the competition from nonunion workers and thereby push up the wages of union members. But without commensurate increases in worker productivity, unions are unable to enhance the wages of all workers. If they could, the average wages in a highly unionized country like the United Kingdom would be higher than in the United States. But this is not what we observe. Wages in the U.K. are at least 40 percent lower than in the U.S., even though nearly half of the workforce is unionized in the United Kingdom compared to less than 20 percent in the United States.

Without high productivity per worker, there can be no high wages per worker. Similarly, without growth in the production of goods and services valued by consumers, there can be no growth in the real income of a nation. Production provides the source of income.

THE GOODS AND SERVICES THAT PROVIDE for our standard of living do not just happen. Their production requires work, investment, cooperation, machinery, brain power, and organization. There are four major sources of production and income growth.

First, improvements in the skills of workers will promote economic growth. Skilful workers are more productive. How do individuals improve their skills? Primarily they do so by investing in themselves - by developing their natural abilities. There are literally thousands of ways people can improve their skills, but most of them involve studying and practising. Thus, education, training, and experience are the primary ways people improve their skills.

Second, capital formation can also enhance the productivity of workers. Workers can produce more if they work with more and better machines. For example, a logger can produce more when working with a chain saw than with a hand-operated, cross-cut blade. Similarly, a transport worker can haul more with a truck than with a mule and wagon. Other things constant, investment in tools and machines can help us produce more in the future. But investment is not a free lunch. The resources used to produce tools, machines, and factories could also be used to produce food, clothing, automobiles, and other current consumption goods... Economics is about trade-offs. It does, however, indicate that people who save and invest more will be able to produce more in the future.

Third, an improvement in technology - our knowledge about how to transform resources into goods and services - will also permit us to achieve a larger future output. The use of brain power to discover economical new products and/or less costly methods of production is a powerful source of economic progress...

Finally, improvements in economic organization can also promote economic growth. Of the four sources of growth, this one is probably the most often overlooked. The legal system of a country influences the degree of economic cooperation...

Effective economic organization will facilitate social cooperation and channel resources toward the production of goods that people value. Conversely, economic organization that protects wasteful practices and fails to reward the creation of wealth will retard economic progress.

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Gil C. Schmidt was born. Lucky for him and some 416 people, many of who don't seem to know it. Lives in Puerto Rico, which is convenient because he also works from there. Gil writes about dozens of real things (with relish) and dozens of imaginary things (like phantasmagoric pickles), in separate forums. Author of several books and a son, Gil gets in trouble when he's bored. Please head to the egress now.

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